Today we'll look at Renk Aktiengesellschaft (FRA:ZAR) and reflect on its potential as an investment. Specifically, we'll consider its Return On Capital Employed (ROCE), since that will give us an insight into how efficiently the business can generate profits from the capital it requires.
First, we'll go over how we calculate ROCE. Second, we'll look at its ROCE compared to similar companies. Finally, we'll look at how its current liabilities affect its ROCE.
What is Return On Capital Employed (ROCE)?
ROCE measures the amount of pre-tax profits a company can generate from the capital employed in its business. Generally speaking a higher ROCE is better. Overall, it is a valuable metric that has its flaws. Author Edwin Whiting says to be careful when comparing the ROCE of different businesses, since 'No two businesses are exactly alike.
How Do You Calculate Return On Capital Employed?
The formula for calculating the return on capital employed is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
Or for Renk:
0.088 = €49m ÷ (€781m - €222m) (Based on the trailing twelve months to June 2019.)
Therefore, Renk has an ROCE of 8.8%.
Is Renk's ROCE Good?
ROCE can be useful when making comparisons, such as between similar companies. Using our data, Renk's ROCE appears to be around the 10% average of the Auto Components industry. Separate from Renk's performance relative to its industry, its ROCE in absolute terms looks satisfactory, and it may be worth researching in more depth.
We can see that, Renk currently has an ROCE of 8.8%, less than the 12% it reported 3 years ago. So investors might consider if it has had issues recently. The image below shows how Renk's ROCE compares to its industry, and you can click it to see more detail on its past growth.
When considering this metric, keep in mind that it is backwards looking, and not necessarily predictive. ROCE can be misleading for companies in cyclical industries, with returns looking impressive during the boom times, but very weak during the busts. This is because ROCE only looks at one year, instead of considering returns across a whole cycle. If Renk is cyclical, it could make sense to check out this free graph of past earnings, revenue and cash flow.
Do Renk's Current Liabilities Skew Its ROCE?
Short term (or current) liabilities, are things like supplier invoices, overdrafts, or tax bills that need to be paid within 12 months. Due to the way ROCE is calculated, a high level of current liabilities makes a company look as though it has less capital employed, and thus can (sometimes unfairly) boost the ROCE. To check the impact of this, we calculate if a company has high current liabilities relative to its total assets.
Renk has total liabilities of €222m and total assets of €781m. Therefore its current liabilities are equivalent to approximately 28% of its total assets. A fairly low level of current liabilities is not influencing the ROCE too much.
Our Take On Renk's ROCE
This is good to see, and with a sound ROCE, Renk could be worth a closer look. Renk shapes up well under this analysis, but it is far from the only business delivering excellent numbers . You might also want to check this free collection of companies delivering excellent earnings growth.
If you are like me, then you will not want to miss this free list of growing companies that insiders are buying.
If you spot an error that warrants correction, please contact the editor at email@example.com. This article by Simply Wall St is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. Simply Wall St has no position in the stocks mentioned.
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